Tax deductions for self-employed people

Young African-American woman doing carpentry work and thinking of self-employed tax deductions she may be able to take for her business expensesImage: Young African-American woman doing carpentry work and thinking of self-employed tax deductions she may be able to take for her business expenses

In a Nutshell

Running a business comes with a lot of associated expenses — but luckily you can deduct many of those costs on your income tax return. Check out some self-employed tax deductions you might qualify for this tax season.
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This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma. It has been updated for the 2020 tax year.

Working for yourself means you get to be your own boss, but it certainly doesn’t mean you’re free from paying taxes.

Whether you’re working a gig for extra money, freelancing full time or running your own small business, the IRS considers you to be self-employed. You’ll have to pay income taxes on the money you make from self-employment.

Fortunately, you can reduce your taxable income by claiming certain tax deductions. The key to taking advantage of self-employed tax deductions is knowing what’s deductible.

But first, let’s take a look at who the IRS considers to be self-employed and how the self-employed are taxed.

Am I self-employed?

It’s important to know whether you’re self-employed or an employee, because the distinction has a major effect on your taxes. The IRS considers you to be self-employed if …

  • You’re the sole proprietor of a business or work as an independent contractor in any trade or business.
  • You’re a partner in a business.
  • You work for yourself in any other way (including part time).

That definition can include freelancers, gig workers and any other workers who decide for themselves, rather than having an employer decide for them, what work they do and how they do it.

If you are self-employed, you are generally required to pay self-employment tax in addition to income taxes.

What self-employed tax deductions can help lower my tax bill?

Making money costs money. But if expenses for running your business and turning a profit meet IRS criteria, you can deduct them from your taxable income.

The IRS specifies that to be deductible, business expenses “must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.”

Simply put, this means ordinary expenses are things other business owners in your industry typically purchase. For example, a rideshare driver may be able to deduct gas, water and snacks for passengers, car washes and a cellphone, among other things.

Necessary expenses may be better defined as costs required for your business to succeed. This can include things like business travel or tools for work. To illustrate, a small business owner might be willing and able to pay millions of dollars to advertise during the Super Bowl. Advertising is typically an ordinary business expense, but is an expensive ad necessary? Chances are, an IRS auditor would say no.

The tax deductions that are ordinary and necessary for your business will depend on what type of business you’re in, but some common business expenses include the following:

  • Advertising
  • Business meals
  • Credit card convenience fees
  • Insurance
  • Interest from business debts
  • Legal and professional fees
  • Office expenses
  • Rent or lease
  • Repairs and maintenance
  • Subscriptions
  • Supplies
  • Taxes and licenses
  • Travel
  • Utilities
  • Wages, bonuses, health insurance and other benefits paid to, or on behalf of, your employees

The expenses above are fairly simple, but many other expense categories can save you money at tax time. Here’s a few you might consider.

Home office expenses

If you use part of your home regularly and exclusively as your prinicipal place of business, you may be able to deduct a portion of your housing expenses. These could include mortgage interest or rent, homeowners insurance, utilities and repairs.

There are two ways to deduct home office expenses.

The simplified method gives you a deduction of $5 per square foot of the home used for business, up to a maximum of 300 square feet. Under the regular method, you must keep track of your actual expenses. You must also calculate the percentage of your home that’s devoted to business use to determine how much you can deduct for various housing expenses. For example, if your home office occupies 10% of your home’s square footage, you would take 10% of your mortgage interest, homeowners insurance as your home office deduction.

While the simplified method is easier to calculate, the regular method may result in a bigger deduction.

Keep in mind not every home office qualifies for the home office deduction. Whether you use the simplified or regular method, the home office must be used regularly and exclusively for business and be your principal place of business.

Car expenses

If you use your personal vehicle for business, you may be able to claim a deduction for the costs related to your business use of the car.

There are two ways to deduct car expenses.

  1. Standard mileage rate — Multiply the miles driven for business by a standard rate that is updated each year. For 2020, the standard mileage rate for business miles is 54.5 cents per mile. So if you drove 1,000 miles for business in 2020, your deduction would be $545.
  2. Actual expense method Determine what it took to operate the car for the entire year. That includes costs like gas, oil, repairs, insurance, registration fees, etc. You multiply those expenses by the percentage of miles the car was driven for business. For example, if you drove 10,000 miles during the year, 1,000 of which were for business, 10% of your vehicle’s usage was for business. If your total vehicle expenses for the year were $2,000, your deduction would be $200 (that’s 10% of $2,000).

Dues and memberships

Many self-employed people join organizations to network with other business owners and potential clients. In some cases, the dues and membership fees paid to these organizations are deductible.

However, the IRS specifically restricts deductions for dues and membership fees paid to “clubs organized for business, pleasure, recreation or other social purpose.” So dues paid for country clubs and other clubs organized to provide entertainment to members and their guests are not deductible.

You can deduct dues and membership fees paid to chambers of commerce, professional organizations, trade associations and the like.

Education expenses

If you take classes to maintain or improve the skills required in your business, or ones that are required to maintain your license or job, you can deduct the costs of the courses themselves and certain travel expenses while attending them. You can also deduct the same kinds of expenses if you pay them for an employee.

You can’t deduct the cost of education that would qualify you for a new trade or business. For example, an attorney can deduct the cost of continuing professional education required to maintain their license to practice law. That attorney could not deduct the cost of classes necessary for becoming a financial adviser.

Phone expenses

Do you still have a home phone? If so, you should know that you can’t deduct the cost of the main telephone line in your home, even if you have a home office. However, you can deduct the cost of a second line in your home that’s used exclusively for business. You can also deduct any long-distance charges for business calls made on your first line.

Some self-employed people may have one cell phone from which they send and receive business and personal calls, emails and texts. You can claim a deduction for the cost of your cell phone, but only to the extent that it is used for business. It’s a good idea to keep copies of your itemized phone bills to support your deduction.

Pass-through deduction

The Tax Cuts and Jobs Act of 2017 gave a potentially valuable tax break to self-employed workers: Section 199A, also known as the pass-through deduction.

Section 199A allows pass-through businesses, including partnerships, sole proprietorships, S-corporations and some LLCs, to deduct up to 20% of the qualified income earned by the business. But the law has several limitations, exceptions and phase-outs. Check out our guide to the pass-through deduction to determine if it applies to your business.

Bottom line

For even the smallest business, expenses can really add up. But if you take advantage of self-employed tax deductions, you can reduce the amount you’ll have to send to the IRS. Be sure to track your expenses carefully and keep copies of receipts. That way you’ll have documentation if the IRS has any questions.

A senior product specialist with Credit Karma, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.

About the author: Janet Berry-Johnson is a freelance writer with a background in accounting and insurance. She has a bachelor’s degree in accounting from Morrison University. Her writing has appeared in Capitalist Review, Chase News &a… Read more.